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This emerging growth business looks too cheap

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Sometimes change, or something new within an existing organisation, can drive an improving outlook for a firm and accelerate returns for the company’s investors.

A company under transition

I reckon Quantum Pharma (LSE: QP) is poised to behave in the way I describe above as the firm transitions to a more focused and simplified business strategy led by a new board of directors.

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The company develops and manufactures niche pharmaceutical products for the retail, wholesale, hospital and home care markets, and full-year results out today show revenue up 28% compared to a year ago, suggesting that the firm continues to gain market share.

City analysts following the firm expect pre-tax profit to shoot up 15% for the year to January 2018 and 17% the year after that, an impressive rate of growth. Yet at the current share price around 44p, Quantum Pharma trades on a forward price-to-earnings (P/E) ratio of just over 10 for year to January 2018.

I think that rating undervalues the firm, given its potential, and a re-rating upwards to a higher P/E ratio could materialise if the directors’ transition plan works out as anticipated.

A clean sweep

It arrived on the FTSE AIM market during December 2014, but during 2016 recruited a new chief executive, finance director, non-executive chairman and several non-executive directors in a move that swept away the old board and ushered in a new strategy.

A placing during October raised £15m before expenses and bolstered the strength of the balance sheet, and the new directors closed a lossmaking division at the end of the year, which has since gone into administration. The new chief executive, Chris Rigg, explains in in today’s report that the firm has achieved a “step change in the profitability of the Niche pharmaceuticals division in the second half by focusing on launching and commercialising products where we have a competitive advantage.”

On top of that, the company says it renewed exclusive contracts with three of the four main wholesale and pharmacy chains in the UK and reduced operating costs. Meanwhile, net debt at the year-end came in lower than the directors expected at £13m, which looks manageable at around half the level of gross profit.

With improved profitability and a narrower focus on a simplified array of niche product lines, the outlook for future growth is good. A rejuvenated Quantum Pharma looks poised to rise phoenix-like from the ashes of the old.

Why are the shares cheap?

The company has been through a complicated transformation process during 2016 and events could have muddied the water making it hard to see what’s going on in the business. The placing raised the share count, so there is a decline forecast for earnings per share for the year to January 2018.

It’s only by looking at forecast figures for pre-tax profits that we can see the underlying progress that City analysts think the firm will make. I think the emerging growth we are seeing with Quantum Pharma is worth more than the forward P/E of 10 or so that the market assigns to the company because next year’s forecast for growth in earnings per share is around 14%.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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